As of this writing, the average credit score in America has reached an all-time high…
Where should I buy a house that will be most suitable for my lifestyle? Should I live in the suburbs or further out in the country? How much space can my savings afford?
These are just some of the questions that will start running through your mind the moment you decide that it’s time for you to buy a home. But once you’ve seen your credit report and realize that you need more help making this big purchase, there’s probably one more question we need to add to this list: Is it possible to qualify for a mortgage with a 500 credit score?
Whether you need to apply for personal loans, credit cards, or mortgage loans, there are minimum credit score requirements you have to be aware of and satisfy. Since most people automatically think of a 500 rating as bad credit, it’s worth your time learning about the different home loans out there you can still apply for to get the home of your dreams.
Even before you start shopping around for loan options, there are some more necessary data you should find out about yourself because these will also matter to your mortgage application as much as your credit score. Let’s discuss them briefly in this section.
Even though you are hoping to borrow money for a home purchase for the very reason you cannot afford to pay cash upfront, down payments are still inevitable for most home loans in the market. They also make more sense because the more money you owe, the more expensive your house becomes in fees and the interest you need to pay. How much home you can afford will depend on how much savings you have already built.
According to the National Association of Realtors, first-time home buyers usually make about a 7% down payment. In comparison, those who buy second homes or already have experience in real estate purchasing typically put 16% money down. Of course, you still won’t want to pay all your savings towards a down payment, and there’s always the chance you might find a house you cannot afford regardless of how much money you’ve put away. Furthermore, depending on your qualifications, you might be eligible for a zero-down payment mortgage. It will be something you have to decide for yourself based on your situation.
As a general rule, it’s always a better idea to pay as much money down as you can, even when it’s not required. It will help you earn home equity faster, and lenders will feel more confident about your application. Not to mention, you’ll pay a lot less in interest by the time you finish paying off your mortgage.
Knowing if you can make any down payment can provide you with a marker for your readiness to make this life-changing decision.
Another thing you have to prepare is your debt-to-income ratio (DTI). Aside from credit score, mortgage lenders also require specific DTI ratios, and they vary a lot.
Most people will find out their own DTI from their broker or through the application itself, but there’s a more straightforward way to ensure you’re getting yourself ready for your mortgage.
Your DTI is how much money you pay towards your debt every month versus how much money you make through your job. Ideally, at least 60% of your income should still be leftover after you’ve paid your debts. It is important because lenders want to know you’ll at least have 60% for your other obligations and needs that may arise.
You might have to break out your calculator and start doing some math to get these numbers, but it might be easier to remember that before you apply for a mortgage, you have to do your best to pay down as much debt as you can pay also boost your income. You can see about a promotion at work, or you can find a worthwhile side hustle in the months leading to your mortgage application.
Your DTI ratio can be a make-or-break criterion, and, as they say, prevention is better than cure!
Mortgage Loan Options
Now, it’s time to find out which type of mortgage you can get with a 500 credit score.
A credit score of 500 might be the lowest you can go and still qualify for a mortgage.
According to Experian, one of the big three major credit bureaus, 99% of American consumers have a credit score of at least 500. And even though a particular government agency can set minimum credit score requirements (or none) for a kind of mortgage they insure, it is still up to the mortgage lenders whether they’ll prescribe overlays. So be informed that it’ll be to your advantage if you can get your credit score higher before the lender receives a chance to view your recent credit report.
Government-Backed Loan vs. Conventional Loan
According to who steps in, there are two general types of mortgages if you fail to repay your loan. First, if a government agency insures your mortgage, this is a government-backed loan. Second, on the other hand, if you are borrowing directly from a private financial institution, what you’re getting is called a conventional loan.
There was a time when government-backed loans didn’t exist. Instead, conventional loans, the traditional kind of mortgage, were the norm. But these conventional mortgages made it difficult for many Americans to avail a home loan due to the higher minimum credit scores required. So the government eventually had to step in and ensure that there were always people buying houses on the market.
The Federal Housing Administration (FHA) under the Department of Housing and Urban Development was created in 1934. The Department of Veterans Affairs (VA) started helping servicemembers and veterans buy houses beginning in 1944. And much later, the U.S. Department of Agriculture (USDA) started ensuring housing loans back in 1991.
With a 500 credit score, you will be ineligible for conventional loans because mortgage lenders ask for a minimum credit score of 620. But you do have some options through government-backed loans. Note that if you get a government-insured mortgage, the house will need to become your primary residence for at least one year, so this is not an option for a temporary house or a vacation home.
Let’s start with the basic type of home loan because this one is available to everyone regardless of where you’re buying a home or your professional background.
The minimum credit score needed to qualify for an FHA loan is 500, but you have to make sure that you have money for at least a 10% down payment with this kind of credit score. If you can reach a credit score of at least 580, you will be allowed to borrow more money and make a smaller down payment of 3.5 percent.
Although ten percent sounds a bit steep, considering that first-time homebuyers often pay just 7 percent, the good news is there are things you can do to raise this kind of money. Depending on your location, there might be local down payment assistance programs you can approach because these usually partner with the FHA. Or, if you can get lucky, there might be friends or family members who’d be willing to help you out with the funds needed for a down payment. It will strictly be considered as gifted funds, though, so your friends and family will have to state in writing that they won’t be asking you for repayment in the future.
This next loan type is a lot more niche compared to the FHA loan. To get a VA loan, you have to either be a service member, a veteran, or surviving spouse of a veteran who has passed away. However, check any of those three, and you might not have to worry about your credit score.
For the VA loan, there is no particular minimum credit score requirement. As we’ve mentioned, though, you’ll still have to check with the lender you are approaching. Sometimes, lenders feel confident enough with the VA backing 25% of the loan. Frequently, however, mortgage lenders want to ask for a credit score over 600. Ask your circle to find out what their mortgage lenders require for their applications.
The VA loan is a considerable help for our veterans because they are not obliged to make any down payment. There is also no mortgage insurance, although a small VA funding fee is paid at closing, and this amount is based on the borrower’s entitlement.
Finally, if you have no military experience and you prefer to put no money down, you can see if your house can be eligible for a USDA loan here.
The main requirement of USDA loans that sets it apart from others is the rural area requirement. Your credit score does not matter as much as with FHA loans, but you have to prepare yourself with relevant documentation to justify your lower credit. If you got bad credit because you got stuck with student loans or hospital bills, these circumstances might help your mortgage application for a USDA mortgage.
What makes it hard for some people to qualify for USDA is the maximum household income requirement. Your application will also include information about other household members. This income limit depends on your location and the number of persons living in the home.
Like the VA loan, the USDA loan is a zero-down payment loan program. There is mortgage insurance, though, but it is a lot less than the insurance charged for conventional loans.
Important note if you’re getting a USDA mortgage: since the pandemic started, mortgage lenders have been more stringent with credit score requirements, and some even ask for as high as 640. It’s a lot harder these days to find a lender who’ll approve with a credit score of 500.
Mortgage applications are understandably nerve-wracking, especially for borrowers with credit scores considered low. So let us share with you one tip for a more stress-free experience.
Consider getting a mortgage pre-approval letter even before you start seeing houses. You can look at your bank statement or home prices on Zillow all you want, but the best person to quote you on your budget will be your mortgage lender.
When you get pre-approved for a mortgage, you’ll go through the same basic motions as in the actual mortgage application. Your DTI ratio will be computed, and you’ll find out precisely what it is and how much it will be should you get approved for a mortgage. The credit check that the lender will do will be a hard inquiry and will affect your credit score. However, in between this mortgage pre-approval and your search for the perfect home, there can be enough leeway for you to boost your credit score.
If you get pre-approved for a mortgage, you’ll find out how much money the mortgage lender is willing to let you borrow, and you can use this as a basis for choosing the house you want to buy. With this in mind, there can be a lesser chance of heartbreak if you find yourself deadlocked in a particular home. Finally, it can assure the home seller that you can get financing, especially in this climate of rising home prices.
Are you ready to find your dream home?